The Puerto Rico government’s reshuffled debt strategy points to its reduced financing options and increased market access risks, Moody’s Investors Service said Wednesday.
Puerto Rico is scaling back planned bond issues as the island’s debt has taken a beating by investors in recent weeks over concerns about the island’s economy and fiscal condition, Detroit’s bankruptcy and wider problems in the U.S. municipal bond market.
“Several factors have contributed to Puerto Rico’s sharply increased credit spreads in recent weeks, increasing the commonwealth’s refinancing risks and exposure to capital markets,” Moody’s said in an issuer comment Wednesday.
As Puerto Rico has put the brakes on some planned long-term issues for the rest of 2013 it has recently raised nearly $1.8 billion through a number of short-term financing deals to strengthen government liquidity and wait out unfavorable market conditions.
“This strategy reflects reduced financial flexibility, and at the same time increased market access risks,” Moody’s said.
The report was issued the same day that Puerto Rico government officials announced that they would seek to expand the borrowing capacity of their top rated credit to obtain more cost-effective financing for commonwealth debt.
Treasury Secretary Melba Acosta and interim Government Development Bank President José Pagán said they were filing legislation Wednesday to the increase the financing capacity of the Sales Tax Financing Authority (known as COFINA) that emits bonds backed by the commonwealth’s 7 percent sales & use tax (known as the IVU). The amendments would increase to 3.5 percent from 2.75 percent the percent amount of the sales tax that can be used for borrowing.
That move came while Acosta and Pagán are in New York City for the second time in less than a week working to instill confidence in the bond market after a rough stretch and head off a potential downgrade by stressing to credit-ratings agencies that Puerto Rico is on the right path to fiscal stability and economic growth. Gov. Alejandro García Padilla is also on an official trip to New York, with a sitdown with representatives from Moody’s Investors Service on Wednesday.
Moody’s, Standard & Poor’s and Fitch ratings all rate Puerto Rico’s GO credit a single notch above noninvestment, or junk, grade, with a negative outlook. Moody’s downgraded the GOs in December and the other two agencies followed suit.
All three credit-ratings agencies peg COFINAs solidly at investment levels with stable outlooks.
Puerto Rico’s GO debt has a constitutional guarantee, while Cofina bondholders are protected by provisions that enable them to get paid off first from the IVU before the government gets paid. In some cases, tax revenue supporting public corporation debt can be “clawed back” to cover GO debt should revenue fall short and the government becomes insolvent.
The new Moody’s report explores recent market events and their impact on the commonwealth’s fiscal profile including widening municipal spreads across the market, but “disproportionately” for Puerto Rico’s securities.
Puerto Rico’s securities are widely held by a diversity of bond funds due to its triple tax-exemption and large volume of debt. As awareness of Puerto Rico’s credit challenges has grown, some fund buyers, including state-specific funds, indicated a desire to reduce their fund exposure to the commonwealth’s various debt securities by selling holdings.
“At the same time, non-traditional investors, including high yield and distressed debt investors, have taken increased interest in Puerto Rico’s securities, attracted by the relatively high yields and large supply of paper for investment grade municipal issuers. As funds have reduced exposure and more speculative investors have accumulated positions, the relationship between yields on Puerto Rico obligations and various municipal indices has been volatile while trending wider,” Moody’s said.
The credit rating agency points to a deepening decline in Puerto Rico’s economy in recent months after some signs that the island was crawling out of a seven-year recession.
Puerto Rico’s economy fell for a ninth straight month in July, plunging by 5 percent compared to the same month in 2012, according to the latest GDB-EAI.
The report said that the average cumulative value for calendar year 2013 (January-July) showed a reduction of 3.5 percent with respect to the same seven-month period in calendar year 2012.
The index fell across the board in July and was down in all four categories measured for the fiscal year: total nonfarm payroll employment, electric power generation, gasoline consumption and cement sales.
Not only does the GDB-EAI show a continuous decline in economic activity, but the extent of the decline has been growing throughout 2013.
The GDB-EAI had returned to growth in December 2011 for the first time since Puerto Rico’s recession began in 2006. It showed small but consistent year-over-year gains for nearly a year before beginning to retreat again last October. Since then, it has been on a steadily steepening decline: falling 0.7 percent in November, 2012, 1.3 percent in December, 2012, 1.8 percent in January, 3.1 percent in February, 3.1 percent in March, 3.5 percent in April and 3.4 percent in May and 4.5 percent in June.
“These actual results compare negatively to the commonwealth’s prior forecast of 0.2% growth for fiscal 2014,” Moody’s said. “While yields in general have widened, this confluence of events contributed to a further widening of Puerto Rico yields despite positive steps taken by the government to increase revenues and reform the commonwealth’s troubled pension system.”
Certain tax exempt Puerto Rico maturities have traded with yields as high as 10 percent in the past two weeks, levels not frequently seen for investment grade municipal paper in the still historically low interest rate environment.
As a result, the Puerto Rico government has scaled back its borrowing plans for the balance of 2013 from $2.6 billion to a range between $500 million and $1.2 billion. The commonwealth had initially planned to issue approximately $600 million in general obligation bonds this fall to cover part of budgeted $575 million of debt service restructuring and $245 million of deficit financing. The Puerto Rico Highways & Transportation Authority had also planned to issue $1.7 billion to $2 billion of revenue bonds in multiple offerings to refinance the public corporation’s obligations to the GDB during fiscal 2014.
In the meantime, the commonwealth has issued several unrated short-term private placements to meet its liquidity needs, including $1 billion in general obligation tax revenue anticipation notes (TRANs) for the fiscal 2014 budget, $400 million in PRHTA bond anticipation notes (BANS), and $400 million in general obligation BANS, and plans to issue at least $200 million in additional TRANs for budgetary support before the end of the year.
The GDB raised $400 million in bond anticipation notes (BANs), which will be used to pay off a portion of the $2.2 billion line of credit it has extended to the Highways & Transportation Authority, GDB interim President José V. Pagán Beauchamp said.
The PRHTA BANS were used to pay off a portion of the $2.2 billion line of credit the GDB extended to the authority. The GO BANs refinanced GDB and private bank loans and financed a portion of the debt service restructuring for fiscal 2014.
Puerto Rico also issued a $333 million BAN secured by sales tax revenues (issued through COFINA) in April of this year as part of the commonwealth’s total $1.1 billion fiscal 2013 deficit financing.
“The short-term borrowings allow the commonwealth to meet its combined $1.2 billion near-term cash needs on a timely basis without accessing the capital markets. However, the reliance on short-term borrowing increases its exposure to refinancing risk, which had been relatively modest until now,” Moody’s said.
“If market conditions remain unfavorable, or the commonwealth is unable to roll the short term financings, it would likely look to the GDB to support the notes’ repayment,” Moody’s said, adding that the GDB is an important component of its analysis of the commonwealth’s refinancing risk profile.
“The commonwealth’s revised financing strategy has shown that their financial flexibility has been reduced, though lending from private sector banks continues,” Moody’s said.
The credit-rating agency deems the subordinate PRHTA BAN terms favorable in the short term, but noted carry high penalties if not repaid within 12 months. The PRHTA BAN is structured with steeply increasing interest rates, raising the cost of funds from 2.4 percent if the bonds are redeemed within 12 months to 11.4 percent if the bonds are not redeemed within 18 months. (The TRANs were all issued as short-term private transactions and terms of the financings have not been disclosed.)
The commonwealth, however, has been able to take advantage of the low interest rate environment the past several years and proactively refinanced its debt lowering overall interest costs, Moody’s said, pegging the current public debt outstanding at more than $70 billion of public debt outstanding and net tax-supported debt outstanding at more than $52 billion.
While rising rates will increase the commonwealth’s overall cost of funds, it is unlikely to represent a significant increase over the current cost of funds, according to Moody’s.
Moody’s noted that the Treasury Department said tax collections are ahead of projections for the first two months of fiscal 2014 (July-August) but trail collections from the same period a year ago as new revenue measures begin to come online.
The $9.77 billion general fund budget for fiscal 2014 (which started July 1) is a $688 million increase over the fiscal 2013 budget. The consolidated fiscal 2014 budget, which includes federal funds, will near $29 billion.
The budget contains $1.38 billion in revenue from a range of new taxes and collection efforts.
There is a lot riding on meeting those tax targets as the administration works to avoid a credit downgrade to junk territory.
Moody’s Investors Service said in an earlier report that revenue from a range of new taxes and collection efforts implemented to fund this year’s budget have “mixed credit implications,” with Puerto Rico maintaining its investment grade dependent on whether revenue targets are met.
“Further weakening of economic growth could result from the additional corporate and sales taxes, as well as increased tax compliance and enforcement measures,” Moody’s said in July. “Despite the increase in much-needed recurring revenue for the commonwealth, weaker economic conditions would also increase negative pressure on the rating.”
The commonwealth had planned $820 million of deficit financing and debt service restructuring for fiscal 2014, and that amount could increase if projections fall short, Moody’s said Wednesday. While net liquidity at the GDB was over $3 billion at the end of fiscal 2012, that amount has narrowed significantly due to continuing loans to the commonwealth and other authorities and the inability to refinance certain lines in the long-term market.
The GDB reports that it has access to approximately $2.8 billion in public deposits of the commonwealth’s agencies, public corporations and municipalities at private banking institutions which are in the process of being moved to GDB.
“If the GDB is unable to strengthen its liquidity position and the commonwealth faces extended difficulties accessing the long-term market, the commonwealth’s overall liquidity position could become severely strained,” Moody’s concluded.